Focus on Private Sector: An end to tech tax dodging

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International tax enforcement and tech to track profits could stop this

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Google and the UK government recently announced an agreement for the technology giant to pay back £130 million (US$181 million) in taxes owed over the past ten years. Activists say the deal is too lenient, and an inquiry by a UK parliamentary committee reported this week that the government could have done more. [1] But it is nevertheless a step forward that governments are beginning to act on tax avoidance.

“Tax avoidance is devastating for developing countries, which lose as much as US$100 billion a year in revenues due to the failure to collect taxes from foreign corporations”

Maha Rafi Atal

This limits the ability of developing country governments to deliver essential public services such as health or education, which are not only humanitarian necessities, but critical ingredients for driving economic growth.

Corporate tax avoidance often takes the form of transfer mispricing. If, for example, a US company sells mobile phones in Europe that are assembled in China using chips made from metals collected in Zambia, the company will have subsidiaries in each country and each subsidiary will be taxed locally. For accounting purposes, the subsidiaries are independent companies trading with each other. The Zambian subsidiary spends money to mine the minerals, and puts down in its accounts that it has ‘sold’ these to the Chinese subsidiary, which writes in its accounts that it has ‘sold’ the finished phones to the sales subsidiary in Europe, which puts down in its accounts the price for which it sold the phones to consumers, and either takes this as profit, or ‘sells’ its revenue up the chain to the parent company.

Because no cash actually moves between a multinational’s divisions in such internal transactions, companies have leeway in what ‘prices’ they put down for the internal trades. By manipulating these prices, companies can choose which subsidiaries look to local tax authorities as though they have turned a profit.

In effect, the single profit that comes from phone sales is distributed across the subsidiaries. By declaring most of that profit in nations where taxes are lowest and declaring losses in countries where taxes are high, multinational corporations reduce their tax burden. These manipulations deprive high tax-rate countries of both tax revenue and earnings that can be reinvested in businesses locally rather than further up the chain, at the parent company level.

Tax avoidance by multinationals means that, while developing country governments adopt neoliberal policies — like privatisation of state-owned businesses — to court foreign investment, their citizens don’t see the benefit of the investment when it arrives. Tax avoidance thus helps stoke public opposition to foreign investment and international trade, and spark protests pushing governments towards protectionist policies that further restrict growth.

What can be done? First, developing and developed countries must work together. In 2014, the OECD (Organisation for Economic Co-operation and Development) recommended an international tax enforcement system. The OECD proposal particularly considers the challenges posed by digital companies, whose value chains include many intangible components that are hard to assign to a particular geographic subsidiary. [4]

Maha Rafi Atal is a PhD candidate at the University of Cambridge, United Kingdom, where she is researching the political effects of multinational firms acting as public service providers in the developing world. She was previously a journalist, including at Forbes, where she covered the intersection of business, development and international affairs. You can contact her on [email protected] or follow her on Twitter: @MahaRafiAtal